FIRE Starter: Advice on Saving & Investing in Your 20s [Part 3]

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Zach is back with Part Three of his nine actionable tips for saving, investing, and growing wealth in your 20s. If you missed Part One or Part Two, take a moment to get caught up, and then come back to read Part Three. The information in this series could change the rest of your life if you follow it.

A Quick Reminder of Why I Started This Series

For the astute observer, you will notice that I have added three new series to the blog: LateFIRE, FIRE Starter, and Chasing FIRE. Notice a theme? They all capitalize on the explosion – one might say the COMBUSTION – in the FIRE (financial independence retire early) movement. But let’s set the record straight: on the GYFG blog, “FIRE” is defined in a slightly different way, as I see it meaning Financial Independence / Recreational Employment. That’s because I am after freedom, not a typical retirement, and see myself working forever. But once I hit my number, my employment will represent my recreational choice.

At 32, I find myself on the older end of the millenials’ age range, which in 2018 is 22-37, according to the Pew Research Center. Guys like Zach have got me thinking that there is a younger part of my generation that may not be able to relate to where I am in life personally. Thus the decision to bring on Zach as a regular GYFG contributor, to reach those younger millenials. He will be writing about earning, investing, and saving money in your 20s. At 24, with a net worth in excess of $100,000 and an income approaching six figures (a significant portion of which is passive income), he is more than qualified. Believe me when I say there is always someone younger and better than you out there, and Zach is putting my own 24-year-old self to shame. I share that only to say that I wish I had been reading people like Zach when I was in my early 20s.

Without further delay, I figuratively pass the mic –  take it away, Zach!

This is a continuation of the nine actionable tips for savings, investing, and growing wealth in your 20s.

Tips 1-3

Tips 4-6

7. Invest in broad market index funds early and often.

The most straightforward path to growing wealth in your 20s is to simply spend far less than you earn and invest the difference. And when it comes to deciding what to invest in, I personally draw upon the wisdom of investing legend Warren Buffett. 

Buffett is a longtime advocate of index fund investing. In particular, he recommends that the average Joe simply invest in a low cost S&P 500 index fund, which holds the 500 largest publicly traded companies in the United States.

In fact, he believes so strongly in the S&P 500 that in 2007 he made a bet with asset management firm Protégé Partners that the S&P 500 would outperform a group of actively managed hedge funds over the following ten years.

In Buffett’s own words:

“To publicize my conviction that my pick – a virtually cost-free investment in an unmanaged S&P 500 index fund – would, over time, deliver better results than those achieved by most investment professionals, however well-regarded and incentivized those ‘helpers’ may be.”

Buffett wanted to prove just how well an investment in a low-cost S&P 500 index fund could perform against the best actively managed funds on Wall Street.

This chart, taken from the Berkshire Hathaway annual letter, shows the annual performance of the S&P 500 during this ten-year period as well as the five “fund of funds” handpicked by Protégé:

The S&P 500 absolutely destroyed these funds as a whole.

Here’s a visual look at the performance of each of these funds over this 10-year period:

This bet serves as a nice reminder that 99% of us are better off investing in simple index funds rather than picking individual stocks, jumping in and out of the market, and paying money managers exorbitant fees who promise to deliver above-average market returns.

In addition to heeding Buffett’s advocacy for index funds, research also tells us that it’s incredibly hard to outperform index funds. In a 2014 paper by J.P. Morgan, it was discovered that the majority of investing returns actually come from a small group of stocks in the market. Researchers went all the way back to 1980 and looked at stock returns for all stocks that have been in the Russell 3000 (an index that tracks the entire stock market) and compared them to the market average:

Two thirds of all stocks under-performed the market average during this time period, while a select few “extreme winners” (about 7% of stocks) beat the average return by more than two standard deviations.

This illustrates an important point: Most actively managed funds were highly unlikely to pick only the extreme winners, but an index fund would have held all these extreme winners simply because it holds all the stocks in the market.

This helps explain why index funds have a tendency to outperform. They will always have the extreme winners in their portfolio, while very few of the actively managed funds will.

8. Your Savings Rate is the Number One Metric that Determines When You’ll Be Financially Independent. 

“Financial independence” is typically defined as having 25 times your annual expenses saved up. This grid shows how many years it will take to achieve F.I. based on your after-tax annual income and annual spending:

Note: This grid assumes you start with a net worth of $0 and that you invest all of your savings at a 5% annual rate of return.

This grid tells a simple tale: The larger the gap between your income and your spending, the sooner you will achieve financial independence.

It’s also important to keep in mind that your savings rate is dependent on two variables: your income and your expenses. It’s not enough to just earn a high income. You need to be able to save a huge chunk of that income if you hope to increase your net worth at a quick pace.

As cartoonist and author Scott Adams explains in his book “How to Fail at Almost Everything and Still Win Big,” the best way to find success is through being pretty good at two complementary skills, as opposed to being excellent at one. 

Scott used this formula to find his own success in the cartoon industry by creating Dilbert, one of the most successful comic strips of all time. He recognized that his drawing skills were pretty good, but not great. His ability to tell jokes was pretty good, but not great. But through combining these two pretty good skills, he could be a great cartoonist.

In Scott’s own words, 

“My combined mediocre skills are worth far more than the sum of the parts. If you think extraordinary talent and a maniacal pursuit of excellence are necessary for success, I say that’s just one approach, and probably the hardest. When it comes to skills, quantity often beats quality.”

This idea can be applied wonderfully to personal finance. You don’t have to earn a six-figure income to achieve financial freedom. Nor do you have to live on rice and beans to save a significant amount of money. For most people, the most sure-fire approach to improving their finances is through becoming a little better at earning and a little better at saving.

To illustrate this point, let’s return to the grid above. Consider a family who brings in $60k per year and spends $50k per year. Starting from zero, they can achieve financial independence in a little over 41 years:

That’s a long time.

But if this family can bump up their annual income to $75k and reduce their annual spending to $40k, they can achieve financial independence in only 18 years. 

This is the magic of being pretty good at both earning and spending. A household income of $75k is not astronomically high by any means. Annual spending of $40k isn’t unusually low. Yet, when you combine these two, the results are incredible. It enables a family to achieve F.I. 23 years sooner. 

This holds true for any income level. Moving down and to the right on this grid is pure financial magic:

The lesson here is simple: focus on boosting your savings rate through increasing your income and decreasing your spending. The more you can do this, the faster you’ll reach financial independence.

9. Be patient.

Lastly, be patient. In the early stages, most of your wealth accumulation will come purely from the difference between your income and your expenses.

As time goes on and you begin to invest more and more savings, investment returns begin to help you. This chart illustrates that point:

If you invest $10k each year at a 7% annual rate of return, you’ll be able to save $100k in 7.84 years. A whopping 78% of this $100k will come purely from your savings. However, by continuing to save and invest $10k each year, your net worth will hit $200k in just 5.1 more years, and nearly half of that additional $100k will come from investment returns! This shows that as time goes on, investment returns become more and more influential in your net worth journey.

This is why it’s so crucial to be patient. Wealth accumulation takes years and decades, not weeks and months.

Even someone like Warren Buffett didn’t become a millionaire overnight. Check out the following chart that shows Buffett’s net worth growth over time:

He didn’t become a millionaire until age 30 or a billionaire until nearly age 60. His path to wealth was built on patience.

Unfortunately, patience seems to have become a virtue of the past. In a world where technology has made instant gratification faster than ever, patience is a virtue that is quickly vanishing. Overnight shipping, high-speed internet, lightning-fast WiFi connections, microwave dinners, and fast food restaurants all subtly influence our expectations on how long we should wait to receive something.

We want our food, our products, and our entertainment at our fingertips in minutes. We hate waiting. Unfortunately this means we are becoming more and more impatient with our personal goals as well. We all want wealth, freedom and success now.

This means the world is full of sprinters, but sorely lacking in marathon runners. 

To accumulate wealth, you need to be a marathon runner and commit to the long game. Don’t stress out about not being rich today, next week, or next month. Be patient. As author Steven Pressfield said in Tribe of Mentors:

“I’m 74. Believe me, you’ve got all the time in the world. You’ve got ten lifetimes ahead of you. Don’t worry about your friends “beating” you or “getting somewhere” ahead of you. Get out into the real dirt world and start failing.”

Don’t obsess over getting somewhere faster than your peers. Just implement healthy financial habits (like these Tips 1-9), keep your spending reasonable, grow your income steadily each year, and be patient. Wealth will come.



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Zach

Zach is a personal finance blogger, an avid weightlifter, and a lover of data visualization. He was personally able to save $100k by age 24 through saving 60% or more of his income each month for two years straight. He is on a mission to teach people how to use principles from the fields of philosophy, psychology, work ethic, and finance to craft a rich and meaningful life.

Comments 1

  1. I love the concept of getting a little bit better at two complimentary skills. There’s often so much debate in the FIRE community about the relative merits of earning more vs. saving more. The answer, of course, is that there’s no reason that you can’t do both.

    I’ve found this concept of complimentary skills has applied to my success as well. I was a pretty good software engineer, and I’m pretty good at talking to people and understanding them and their needs. These two things combined into making me really good as a software salesperson, and that’s how I’ve earned my money.

    As an aside – I’d love to hear more about Zach’s weightlifting (his bio says he’s an “avid weightlifter”). Are you a weightlifter in the true sense of the word (C&J + snatch) or a guy who likes lifting heavy shit?

    In my experience, the kind of person who loves personal finance is the kind of person who also likes lifting weights. The appeal of both is being able to see regular, consistent progress towards a goal.

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